RetireMentors

Annuities

Retirement reality: Your principal can’t last forever

Stan "The Annuity Man" Haithcock is an annuity specialist and nationally
recognized annuity critic. Haithcock is the author of six published books on
annuities, including the highly acclaimed “The Annuity Stanifesto.” With over 25
years of experience in the financial-services industry, he has propelled his
“will do, not might do” contractual-guarantees-only mantra to reframe the
annuity category for the transfer-of-risk strategies they were designed to be.
Haithcock is the co-founder of the first direct-to-consumer annuity platform,
annuities.direct. Haithcock is licensed
in all 50 states and is based in Ponte Vedra Beach, Florida. You can learn more
at
stantheannuityman.com.

Everyone's dream scenario is to receive an income stream without invading the principal. Too many advisers will tell you that this is possible in order to sell you something, so it's important to understand the contractual realities of having your income cake and not eating into the principal, too.

Principal protection is a sacred belief

In Moshe Milevsky's must-read book, “The 7 Most Important Equations For Your Retirement,” Milevsky writes that the realization you will have to eat into your principal for retirement income is one of the most difficult concepts for people to accept. Most people view their retirement lump sum as a truly sacred thing. It's almost a religion to the Depression-era demographic and their offspring to guard their money and try to never disrupt the principal. My parents are like that, and their parents definitely taught them that lesson.

The problem with this inherited belief system is that with current interest-rate levels, it's impossible to contractually guarantee the income needed at reasonable levels without transferring risk to an annuity company or drawing down the principal. There are no financial circus mirrors that can solve this issue.

Jimmy Carter now builds houses

Because baby boomers and seniors remember the high interest rates of the Jimmy Carter years, many still have a false hope that they can somehow relive those times again. I'm going to play the role of the grim reaper, and tell you that you will probably never see those rate levels again in your lifetime.

This is the reason that too many people own annuity income riders (attached benefits) that guarantee 7% or 8% growth and can only be used for income. But many people own them under false assumptions. Many of them weren't told or failed to read the contract to know that the high-income rider percentage growth is worthless unless you use it for income and take payments to access that amount. You can't peel off the interest from an income rider, or access the lump sum from that high percentage growth. A ton of people who own these annuity benefits are under the delusion that they can, and the excrement will hit the fan when all of those recent annuity buyers eventually find out this contractual reality.

The common sense bottom line is that if the 10-year Treasury is yielding less than 3%, then some annuity company doesn't have an actuarial genius locked in a room that has figured out how to create a true yield of 7% or 8%. Wake up, annuity-buying Americans!

How much does it really take?

The mathematical reality of how much money it actually takes to create a typical income stream is truly a wake-up call to most people. In Milevsky's previously mentioned book, he laid out the numbers like a sledgehammer hitting you in the forehead.

Milevsky points out that for a 30-year guaranteed retirement (non-annuity) income stream of $50,000 a year at a real interest rate of 3% (net after inflation), you would need $989,051. For $75,000 a year at the same 3% net interest rate, the initial lump sum needed is $1,483,576. For $50,000 at a net interest rate of only 1%, you will still need $1,295,909.

Those are intimidating lump-sum requirements for most Americans, but the scariest and most difficult number to achieve is the real-rate-of-return number. It might sound low, but think how hard it is in today's environment to find a 3% guaranteed no-risk return that is net of inflation. Can anyone say “impossible”? If you need a lifetime income stream, how probable is it that you won't have to dip into your sacred principal or transfer some of that risk to an annuity company?

Milevsky is a financial realist, and looks at return numbers after subtracting fees and inflation (i.e. real rate of return). He believes that in today's world, this real rate of return should realistically be around 3% or lower without putting your money at risk. I know you market-guru types are salivating here for an argument, but you know that he is right.

This reminds me of the weekly calls I get from people who are not only sad and delusional, but are ripe for the picking for unscrupulous financial advisers. There was the 60-year-old person who wanted a lifetime income stream of $35,000 for him and his wife using a total of $500,000 without touching the principal; or the widow who was told that the indexed annuity would actually yield 8% annually. The sad part is that if they call enough advisers, or watch enough annuity Internet videos, someone will eventually tell them what they want to hear in order to make a commission.

Can the yield planets align for you?

I'm sure that I will receive numerous emails from advisers (aka: masters of the universe) that proclaim they can do this cake-eating financial magic trick for their clients. I guess anything is possible if the numbers are big enough, but it's probably unhealthy to yearn for this once-in-a-blue moon financial eclipse. I would rather you focus on something that has a better chance of happening, like having washboard abs or winning the Powerball lottery.

If you need additional lifetime income at normal levels, you are going to have to come to the realization that you are going to have to eat into that sacred principal. That's just a mathematical fact. It's also the reason that too many people are attracted to annuity upfront bonuses or high income- rider percentages under the false hope of not touching their lump sum.

At the end of the day, it comes down to maintaining your lifestyle, and that might mean little Johnny won't get the inheritance he is waiting around for. A fancy way to say that you can't take it with you is that there are no U-Hauls behind hearses (great country music title). Eventually, you will probably have to invade your principal to achieve your income goals. I'm just here to tell you that it's OK, and just part of life and the current rate world we all live in.

Intraday Data provided by SIX Financial Information and subject to terms of use.
Historical and current end-of-day data provided by SIX Financial Information.
All quotes are in local exchange time. Real-time last sale data for U.S. stock quotes reflect trades reported through Nasdaq only.
Intraday data delayed at least 15 minutes or per exchange requirements.